It Doesn’t Pay to Be a Pessimist

“A bad meme – a contagious idea – began spreading through the United States in the 1980s: America is in decline, the world is going to hell, and our children's lives will be worse than our own. The particulars are now familiar: Good jobs are disappearing, working people are falling into poverty, the underclass is swelling, crime is out of control. The post-Cold War world is fragmenting, and conflicts are erupting all over the planet. The environment is imploding – with global warming and ozone depletion, we'll all either die of cancer or live in Waterworld. As for our kids, the collapsing educational system is producing either gun-toting gangsters or burger-flipping dopes who can't read.” —Peter Schwarz and Peter Leyden, Wired Magazine (1997)

Sound familiar?

For many of us, myself included, the desire to become a sophisticated and successful investor quickly leads into the world of economics and geopolitics. As we learn more about the world around us, it becomes evident just how many dangers lurk around each corner, threatening to shock the global economy and extinguish massive amounts of wealth.

In some cases, the naïve investor who doesn’t pay attention to any of this is actually better off than those of us who do. That’s because the more you learn about the precarious state of global economies, the more reluctant you become to invest.

Need a few examples?

Right now I could cite dozens of risk factors that have the potential to severely disrupt markets. Consider the following:

Subpar global economic growth

Lack of inflationary forces

Ballooning debt to GDP ratios all over the world

Widening wealth gap

The rise of algorithmic and high-frequency trading

The rise of automation

Breakdown in correlations between asset classes

Demise of the dollar as the world’s reserve currency

A volatile and unpredictable US administration

Declining soft and hard economic data

Historically elevated valuation levels

Massive slowdown in China’s economy

Falling commodity prices

Federal Reserve on a path of monetary tightening

This list could go on and on and doesn’t include some of the more transparent risks such as a confrontation with N. Korea or the trend toward anti-globalization.

The point is that if you want to be a pessimist, it’s not hard to find justification. But keep in mind that from an investing perspective, this is a very bad mindset to have.

If I had removed the dates included in the excerpt that began this article, as well as the cold-war reference, would you have known that statement was made in 1997? Would you also have guessed that the US stock market would experience a roughly 270% gain (dividends reinvested) over the subsequent 20 years?

Probably not.

In my interactions with investors, I frequently hear the complaint that the markets are rigged, that they’re biased. My response? You’re absolutely right they’re biased – they’re biased toward the upside.

Think about it … over time, which direction do stock markets go? Up.

Yes, they go down for periods of time every now and then, but take a look at a long-term chart of any developed country’s stock market and the trend is always the same. Over time stock prices move from the lower left to the upper right.

If there is one investor who stands out above all others as a true anti-pessimist, it’s Warren Buffett. Warren has a habit of eloquently presenting alternative truisms about some of the society’s most controversial themes. In explaining why it does not pay to be a pessimist, I’ll present a few of his arguments.

Warren attributes the massive advances that society has made and the tremendous wealth it has created to “economic dynamism.” In his latest letter to Berkshire shareholders, he notes that “From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.”

He goes on to note the reason for our prosperity: “Above all, it's our market system – an economic traffic cop ably directing capital, brains, and labor – that has created America's abundance.”

He continues:

Early Americans, we should emphasize, were neither smarter nor more hard working than those people who toiled century after century before them. But those venturesome pioneers crafted a system that unleashed human potential, and their successors built upon it.

This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the build-up of wealth will be interrupted for short periods from time to time. It will not, however, be stopped. I'll repeat what I've both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history.

America's economic achievements have led to staggering profits for stockholders. During the 20th century, the Dow-Jones Industrials advanced from 66 to 11,497, a 17,320% capital gain that was materially boosted by steadily increasing dividends. The trend continues: By year end 2016, the index had advanced a further 72%, to 19,763.

American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.

But what about those inevitable economic recessions and bear markets that lurk around every corner? Warren’s got a positive outlook on those too:

Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines –even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: "We spend a lot of time looking for systemic risk; in truth, however, it tends to find us."

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.

He continues:

Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.

So … why have I told you all this? Or rather, why has Warren told you all of this?

Because beneath the temporary news stories that fill our everyday lives and keep us focused on short-term (often negative) events, innovation is taking place at the fringes of society. We may not always see this in tangible form (the DMV isn’t exactly operating like a well-oiled Tesla), but it’s there, occurring in back offices, garages, and warehouses around the world.

The best way to take part in this innovation, and the wealth that it creates, is to own stocks. There is no better proof of this than Warren Buffett himself. He didn’t make his fortune off of bonds, or gold, or options, futures, or bitcoin. He made his fortune off the stocks of companies that participated in making our great country what it is today.

The difference between a pessimist and an optimist lies in their default setting. While a pessimist always expects the worst to happen, and that evil will ultimately prevail over good, optimists believe in the future. They believe in mankind. Sometimes that’s a difficult leap of faith to take, but it’s one that has a high probability for increasing your wealth over time.

Think about how a pessimist and an optimist are naturally inclined to invest. The pessimist is likely to always have more money in cash, not only missing out on returns but losing purchasing power to inflation. That same pessimist will also be the one to sell out near the bottom of a bear market, locking in losses as his or her preconceived notions are “confirmed” by falling stock prices.

Optimists, on the other hand, are much more likely to remain aligned with longer-term fundamental trends in our economy, such as that of innovation. They recognize that somehow, some way, our economy, and civilization always advance, and they are more inclined to take risks in order to benefit from these developments. When a bear market arrives, they view it as Warren does, a temporary sale on good quality merchandise that will eventually regain its lost value, and more, as America’s economic dynamism continues.

While we all need a healthy dose of worry and concern in order to be pragmatic investors, it might be worth taking a deeper look inside to see if your natural views on the world are negatively impacting your long-term investment performance. We should never turn a blind eye to market risks, but taking a longer-term view of market action, it’s evident that it pays to be an optimist.

The preceding content was an excerpt from Dow Theory Letters. To receive their daily updates and research, click here to subscribe. Matt is also the Chief Investment Strategist at Model Investing. For more information about algorithmic based portfolio management, click here.